Apple Can’t Top Microsoft in $17 Billion Sale: Corporate Finance
Apple Inc. (AAPL) paid higher interest rates on a record $17 billion bond sale than Microsoft Corp. (MSFT) did a week ago as the iPhone maker’s slowing growth overshadowed annual cash flow that’s more than twice the amount of the issue.
While Apple matched an unprecedented low coupon of 0.45 percent for corporate three-year debt yesterday, investors demanded higher yields for the fixed-rate portions of five, 10-and 30-year securities relative to U.S. Treasuries than similar-maturity notes Microsoft issued on April 25. Apple, which gets more than half of its sales from the iPhone, plans to use the money to help finance $100 billion in dividends and buybacks after its shares plunged 44 percent in seven months.
“Apple is probably seen as a marginally higher risk,” said Alan Shepard, an analyst and money manager at Madison Investment Advisors Inc., which oversees about $16 billion in Madison, Wisconsin, and owns the company’s debt as well as that of Microsoft. “They sell a premium product, but revenues aren’t diversified enough.”
As Apple transformed itself from a near-bankrupt personal-computer also-ran into the world’s largest technology company, the Cupertino, California-based maker of iPad computer tablets and iPod music players has posted annual sales growth that’s been about 10 times that of the Windows 8 designer over the past four years. For bondholders, Morningstar Inc. says competition from lower-cost mobile devices still makes Apple riskier than Microsoft, the world’s largest software company.
Steve Dowling, an Apple spokesman, directed questions about the offering to a term sheet and bond prospectus filed with the Securities and Exchange Commission.
The order book for Apple’s six-part offering, a gauge of investor demand for the debt, reached $52 billion, said a person familiar with the transaction who asked not to be identified citing lack of authorization to publicly discuss the sale.
“In reality, it’s still pretty cheap money,” Lon Erickson, a Santa Fe, New Mexico-based manager at Thornburg Investment Management Inc., who oversees about $6 billion of taxable fixed-income assets, said in a telephone interview. “Would they have liked to save those extra 5 basis points relative to where Microsoft just printed their 10-year? I’m sure they would have but it’s not that big of a cost to them. All in all, they’re probably pretty happy with it.”
Apple’s first debt sale since 1996 included $4 billion of 1 percent, five-year notes that pay 40 basis points, or 0.4 percentage point, more than similar-maturity Treasuries, $5.5 billion of 2.4 percent, 10-year securities with a relative yield of 75 basis points and $3 billion of 3.85 percent, 30-year bonds paying an extra 100 points, data compiled by Bloomberg show.
Those spreads exceed the 32 basis-point gap paid on $450 million of 1 percent debt due 2018 that higher-rated Microsoft sold on April 25, a relative yield of 70 for its $1 billion of 2.375 percent, 10-year bonds and a 90 basis-point spread on the Redmond, Washington-based company’s $500 million of 3.75 percent securities due in three decades.
“Apple’s competitive advantages fall short of those built around other tech giants, such as Microsoft’s Windows and enterprise software offerings,” Michael Hodel, an analyst at Chicago-based Morningstar, wrote yesterday in a report. “We aren’t yet convinced that Apple has created strong enough switching costs to develop a wide moat, as it faces heavy smartphone competition from significantly lower-cost devices.”
Concern that Apple’s pace of sales growth is slowing were reinforced last week by a forecast for narrowing gross margins and sales this quarter that may miss analysts’ predictions by as much as $4.9 billion. Apple had its first profit decline in a decade last quarter as competition in mobile devices from Samsung Electronics Co. intensified.
Apple’s offering also included $3 billion of three- and five-year floating-rate notes and $1.5 billion of 0.45 percent, fixed-rate three-year debt with a 20 basis-point spread, which tied a record-low coupon set by Texas Instruments Inc., Unilever NV and Walt Disney Co.
The deal exploited investor demand for investment-grade debt whose average yields are close to record lows.
While Apple’s deal exceeded AbbVie Inc.’s $14.7 billion offering in November, the iPhone maker paid narrower relative yields than each of the drugmaker’s similar portions, which included $3.1 billion of 2.9 percent, 10-year bonds with a spread of 130 basis points, Bloomberg data show.
Apple’s bonds are the most actively traded dollar-denominated corporate securities by dealers today. Its 30-year securities rose 1.472 cent on the dollar to 100.89 cents at 12:51 p.m. to yield 3.8 percent, or 96.9 basis points more than Treasuries, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The debt was issued at 99.418 cents on the dollar and a relative yield of 100 basis points, Bloomberg data show.
That’s still a higher yield than Microsoft’s similar-maturity securities, which traded yesterday at 99.571 cents to yield 3.774 percent.
“It’s an iconic, well-run company,” said Marc Fratepietro, co-head of coverage, investment-grade capital markets at Deutsche Bank AG (DBK), which managed the sale along with Goldman Sachs Group Inc. “They have incredible products and a stellar balance sheet.”
“That’s an extremely attractive combination for investors,” he said. “You look at prior jumbo deals that have come in the past and they all had much larger size premiums and much bigger concessions to what people would perceive as fair value.”
The offering pushed Deutsche Bank up two levels to make it the fifth-largest underwriter of U.S. investment-grade debt this year, according to Bloomberg data that excludes self-led deals. Goldman Sachs also moved up two spots to become the fourth-largest underwriter.
Goldman Sachs was involved in both of Apple’s most recent bond sales in 1994 and 1996. With Apple approaching bankruptcy in June 1996, then-CFO Fred Anderson hired Goldman to lead a $661 million convertible bond offering that provided the liquidity for Apple’s comeback.
Deutsche Bank advised Apple on its takeover of Next Computer Inc., which was completed in 1997 and led to Jobs’s return to Apple, Bloomberg data show.
Apple generated $45.4 billion of free cash flow in the 12 months ended March 30, 65 percent more than the amount produced by Microsoft, Bloomberg data show.
“You look at them with the cash flow and the overall ongoing strength of their market position today, I don’t think there’s any question that their fundamental story is one of the strongest out there,” Erickson said. “When you look a little bit forward though, and you start to think about the 10-year or the 30-year paper from a pure fundamental standpoint, that’s a long time and it gives plenty of time for that whole market to change.”
Half of Apple’s $156.5 billion of sales last year were accounted for by the iPhone, and 20 percent came from the iPad, Bloomberg data show. Macintosh computers totaled 15 percent, 11 percent of which was portable models.
The rest of the sales came from software and services, including the iTunes online entertainment offering, iPods and accessories, the data show.
Microsoft has three divisions that account for at least 25 percent of sales, none of which is more than a third.
With $17 billion of new bonds, Apple’s debt to equity ratio is about 12.5 percent, still lower than the 18.5 percent at Microsoft, which has $16.9 billion of bonds outstanding and the highest Aaa credit rating from Moody’s Investors Service and an equivalent AAA at Standard & Poor’s.
Moody’s and S&P last week ranked Apple a level lower at Aa1 and AA+. That rating tier is “inconsistent” with Apple’s credit risk, according to Fitch Ratings, which said this week that the company’s “significant liquidity cushion” was offset by the threat of volatile consumer preferences, significant competition and rapid technology changes.
While Fitch hasn’t released a public grade for Apple, it said such a ranking would be likely to fall “at the highest end” of the single-A tier, at least three levels below the AA+ grade it gives to Microsoft.
Yesterday’s Apple offering, which topped the previous record of $16.5 billion set by Roche Holding AG in February 2009, may be only the first portion of Apple borrowings as the company uses bonds to help finance shareholder rewards.
While Apple has $145 billion of cash, borrowing the money may help the company avoid repatriation taxes on its $102.3 billion of funds held overseas as Chief Executive Officer Tim Cook returns an additional $55 billion to shareholders through 2015 to compensate for a stock that’s been hammered by signs of slowing growth.
Using new debt to finance that increase may require annual issuance of $15 billion to $20 billion, Ping Zhao, an analyst at CreditSights Inc. in New York, wrote in a report April 23.
“Microsoft has a much larger installed base with a much better avenue for recurring revenue,” Greg Tornga, the Seattle-based head of fixed income at Edge Asset Management, said in a telephone interview. While the two companies are virtually equal from a bondholder perspective, Apple “just has, by its nature, more cash flow volatility,” he said.
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